This article first appeared in The Edge Malaysia Weekly on October 10, 2022 - October 16, 2022

THE surprise production cut by the Organization of Petroleum Exporting Countries (Opec) and its allies (Opec+) last Wednesday has spooked the oil market once again. And with winter around the corner, the oil and gas (O&G) market is expected to become extremely tight, with forecasts of US$100 per barrel oil being called again.

The cut in output of two million barrels a day announced by the powerful alliance of oil producers is the largest since the outbreak of the Covid-19 pandemic in 2020.

This is also the first time an Opec+ meeting has taken place in-person in Vienna since March 2020, when the pandemic forced everyone to hold meetings online.

The announcement came as a surprise, especially when Opec+ had, less than a month ago, agreed to raise its daily production by 100,000 barrels.

Brent crude oil prices gained as much as 2.05% to US$93.68 per barrel just hours after the announcement of the production cut.

In the first half of the year, Brent oil prices soared to as much as US$139 per barrel after Russia invaded Ukraine.

But since then, it has dropped sharply to below US$90 per barrel on fears that a global recession would depress demand.

Opec+, which controls more than 40% of global oil production, cut its production two weeks ago to pre-empt a potential drop in demand due to the economic slowdown in China, the US and Europe.

However, after weeks of losses prior to the announcement, the O&G market appears to be headed for a rally, not only due to lower oil supply, but also because of a myriad of catalysts, including the expectation of higher demand from the coming winter season and the possibility of China’s economy opening up with the end of its strict pandemic restrictions.

Earlier this month, Chinese President Xi Jinping made his first foreign trip since the Covid-19 outbreak, sending a signal to the market that China could be easing its zero-Covid policy.

Many observers, including US Treasury Secretary Janet Yellen, warn of possible oil price spikes this winter.

“This winter, the European Union will cease, for the most part, buying Russian oil, and in addition, they will ban the provision of services that enable Russia to ship oil by tanker,” Yellen said in a CNN interview early this month. “It is possible that it could cause a spike in oil prices.”

The Energy Information Administration (EIA) estimates that Brent crude oil will average at US$98 per barrel in the fourth quarter of 2022, and US$97 a barrel in 2023. The forecast is based on the possibility of petroleum supply disruptions and slower-than-expected crude oil production growth continuing to support higher oil prices.

In September, Goldman Sachs cut its forecast on Brent crude oil downwards to an average of US$100 per barrel over the next three months, from its previous bullish forecast of US$125 per barrel, because of the deteriorating global economic outlook.

For next year, Goldman sees Brent averaging at US$108 per barrel, down from its previous estimate of US$125 per barrel.

Maybank Investment Bank Research analyst T J Liaw says the bank has maintained its oil price target for 2022 and 2023 at US$100 per barrel on lower production by Opec+.

“The Opec+ group has agreed to cut production by two million barrels per day in November, of which 53% of the cut will be from Saudi Arabia and Russia.

“This is by far the biggest cut by the Opec+ group since the height of the pandemic in 2020. The quantum cut is bigger than the market had anticipated of about one million barrels per day.

“This move reaffirms Opec+’s influential role in providing stability and direction to the oil market,” he tells The Edge.

“This move also goes against the US’ pressure to lower oil prices by increasing output. The production cut, in our view, makes much sense to the oil-producing states — on the economics, operating and political statement fronts — in light of the tightness in spare capacity and the reality in its collective inability to meet production quota in the past,” Liaw adds.

He expects it would take between two and three years for new supply to come on stream following the massive structural underinvestment during the 2015-2021 period.

Maybank IB Research has a “positive” call on the sector, with “buy” calls on Dialog Group Bhd, Yinson Holdings Bhd, Bumi Armada Bhd, Hibiscus Petroleum Bhd, Velesto Energy Bhd, Malaysia Marine and Heavy Engineering Holdings Bhd (MMHE), Wah Seong Corporation Bhd and Icon Offshore Bhd. It has a “sell” call on Sapura Energy Bhd and “hold” on Favelle Favco Bhd.

On the other hand, TA Securities expects oil to be higher at US$105 per barrel this year and US$90 per barrel in 2023, which will be a boon for local O&G companies.

It says the decision by Opec+ would bode well for the oil price and cushion downside risks, and expects the alliance to continue to bolster the oil market moving forward.

“The group’s solidarity sends a strong signal and boosts market sentiment. In particular, we believe this decision would augur well for Opec+’s key member and co-chair, Russia.

“Evidently, strong oil prices are beneficial for the latter, which is still engaged in war with Ukraine. In the interest of this, we believe that Opec+ will likely continue its trajectory of formulating production policy that propels oil price,” TA says in a note to clients.

The research house expects upstream service providers to benefit from escalated oil prices as they are leveraged towards steady O&G capital expenditure (capex) momentum.

“We expect a recovery in daily charter rates (DCR), fleet utilisation and new contract awards. The impetus is higher capex spend from Petronas and other oil companies in these areas’ expansion projects, well drilling, production enhancement, and platform and facilities maintenance,” says TA, which has an “overweight” call on the sector, with “buy” calls on Coastal Contracts Bhd, Velesto, MMHE and Pantech Group Holdings Bhd. It has a “sell” call on Lotte Chemical Titan Holding Bhd, and a “hold” on MISC Bhd and Petronas Chemicals Group Bhd.

The Bursa Malaysia Energy Index, which has been underperforming for the past years, has been showing some signs of investor interest of late.

Since mid-July, the index has gained more than 16% to 702.99 points last Thursday. That is still almost half its recent peak in January 2020 of 1,289.78 points, when Brent crude oil was trading at US$51.54 per barrel.

The recent weakness in oil prices may have given some respite to the escalating inflationary pressure felt in most parts of the world, but that will not last long as supply is expected to remain tight in the coming months.

Subdued oil prices may have taken some edge off stubbornly high inflation in the US in the recent months. Inflation peaked at 9.1% in June, easing to 8.5% and 8.3% in July and August respectively. Inflation fears have also put a dampener on the summer driving season, while the US government’s release of oil reserves have helped cool prices at the pump.

The US has put some pressure on Saudi Arabia and its oil-producing allies to increase production. However, the cutback in production by Opec+ will push up prices just as the winter season is coming.

Socio-Economic Research Centre (SERC) executive director Lee Heng Guie says central banks around the world could step up their monetary policy tightening to tame inflation.

“The firming of crude oil prices would sustain strong inflation pressures, compelling the central banks to step up their monetary tightening to tame inflation and increase the risk of slowing down the economy,” he tells The Edge.

Sunway University economics professor Dr Yeah Kim Leng expects sustained high oil prices to result in a slower transition to a normal inflation level for most economies.

“Opec+’s production cut to offset softening global demand will help to arrest a further decline in oil prices. By reducing supply, the oil producers hope to keep oil prices at an elevated level.

“The high oil prices will result in a slower transition to a normal inflation level for most economies grappling with the post-pandemic inflation surge caused by constrained supply, supply chain disruptions and sanctions on Russia,” he says.

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